In my ten months of owning an investment property, things have run very smoothly. The mortgage is the same one that we had when we were living there; we had refinanced the loan in 2005 to cut 11 years off of our loan for only about $150 extra per month (we did a mortgage refinance to a 15-year fixed-rate mortgage from our 30-year).
Our mortgage is good, and the balance is going down like gangbusters with the 15-year. With the lump sum we threw at it during the refinance, and the small amount extra we're paying toward principal each month, we'll pay it off completely by 2019 if we do nothing different.
Right now, the rent income, minus property management fees, taxes, insurance, etc., makes the cash flow for the property slightly negative, but considering that now over two-thirds of the mortgage payments are going toward principal — that is, equity in the property — I'm not stressing that much. (Actually, truth be told, the fact that I have great tenants is the reason that I'm not stressing that much!)
This home went from a consumer good to a big investment asset
If you've heard something to the effect that “your home is your biggest investment” then (a) you're not alone, (b) I have too, and (c) it's BS. If you're living in said home, it's a consumer good. It's a roof over your head with four walls, wires and plumbing, glass, and some decorations. It's hopefully a durable consumer good, but it's nothing but expenses. It doesn't pay dividends. It doesn't spin off a shed when the garage decides to make an IPO. Put another way, if it's not producing income and serving only as a place to hang your hat, it's not really an investment asset.
But move out, and bring in a rent-paying tenant, then all of a sudden, golly gosh, that same exact house becomes an investment! The expenses are still there (and some new ones show up) but there's income to offset them. Whether the house is a good investment or a bad investment depends partly on whether the property makes or loses money each month. Put another way: Does the property have positive cash flow?
The house became an investment property the day I actively tried to rent the property. We had already moved out into another home, and had decided to make a try at “the real estate rental thing” with our old house. The lender for our new mortgage gladly let us keep the old one, so off we went. We've kept the course with both mortgages — the mortgage on our new primary residence, and the old one as it was — for almost a year now.
Has a bad debt become a good debt?
“Good debt” and “bad debt” are commonly used to differentiate income-enhancing use with consumption-driven use. In many ways, mortgage debt on a primary residence is “bad debt” and is best reduced on an accelerated scale in much the same way that credit card debt should be paid down. If it's afforable, a 15-year mortgage is preferable to a 30-year mortgage because the total interest paid is far less with the 15-year mortgage. That was in fact why we decided to refinance the mortgage on our old house (which we were living in at the time). We wanted to pay it off faster.
But that pay-it-off-faster mentality is working against the cash flow of the property now that it's a rental! Earlier in the post I mentioned that the cash flow was slightly negative for this property. Again, we're not stressed out too much about this, but now we're considering going back the other direction: refinance this mortgage to a 30-year mortgage. After the costs of refinancing, this could add $300-$400 per month positive cash flow to the rental! We'd be paying more in interest to the bank, but maintaining the positive cash flow carries as much, or more, weight than paying off the mortgage on the property. Why? Because this would let the property be an income-producing asset now rather than in 2019 when the mortgage on the property is paid off. It would allow the property income itself to build up a cushion for expenses, repairs, etc., rather than us building up and maintaining that cushion out of other areas in our budget. It would make the property a little more self-sufficient than it was.
Refinance or not, either way would work out. It just seems like going for the longer-term fixed-rate mortgage and the positive cash flow is the more businesslike way to go.
(Thanks to Fabulously Broke for including this post in the Carnival of Personal Finance!)
Have you looked at financing options for an investment property? You’ll probably be further ahead if you co mingle things a bit and refinanced your primary instead of your rental if you need to – you typically have higher costs associated with rental property financing.
@2million: That was at the back of my mind. I had wondered how much more expensive it would be because it would be a different kind of loan.
The longer-term fixed-rate mortgage is definitely the way to go. I wouldn’t look at a different type of loan.
I can see your point about what implications your owner occupancy has for whether or not the home should be regard as an investment. The thing is, a home can still be regarded as an investment so long as it is durable as you say, and it appreciates. Isn’t that kinda what an investment is anyway? Because I have stocks that I have not liquidated, are these still not investments?